Wealth taxes and loosening monetary policy is playing with fire

A response to the article ‘Tax the superrich and raise inflation to cut state debt, inequality and poverty’ in the M&G on 10 November

A recent opinion piece published in this newspaper mentions that, among other ways, the introduction of a wealth tax and high inflation could be a panacea for South Africa’s looming fiscal crisis. But these measures are tantamount to the country playing with fire. The only sustainable way to get the country out of the crises is to reignite economic growth.  

The 2020 medium-term budget, tabled in October 2020, highlights South Africa’s dire fiscal position. The Fiscal Cliff Study Group (FCSG) has warned since 2014 that public finances are developing in an unsustainable way. Simply put, the growth in government revenue could not match the growth in spending, thus pushing government finances to the proverbial cliff.

Because of low economic growth and a concomitant low growth in government revenue, the government reverted to old-fashioned Keynesian deficit spending to try to lift the economy out of its slump. The result of the expansionary fiscal policy was that no reserve capacity for future expansion (or shocks) was created. Gross debt levels continued to climb, reaching levels where the minister of finance himself warned of a “sovereign debt crises”, a debt trap, if no drastic measures were introduced. This is evident from Figure 1.

In the midst of such a looming fiscal crisis, one would expect to find some drastic suggestions being put forward. It’s imperative that these suggestions are properly interrogated against economic theory and empirical evidence. Also important is to take stock of the reason we are at the precipice: the result of a decade of highly expansionary fiscal policy where deficits (and debt) were allowed to increase beyond what South Africa could afford. One expects the suggested solutions and origin of the problem to at least have some correlation. 

Wealth taxes

In determining the feasibility of a wealth tax, the Davis Tax Committee, in its March 2018 report, defined wealth tax as “a tax imposed on the difference between the sum of all gross assets (gross wealth) and the sum of all liabilities at a particular point in time”. It further notes that it can either be an additive wealth tax (“a tax paid only when an asset of market value is sold”) or a substitutive tax (“a fixed tax payment from either capital or annual income earned by owning an asset”).

The 10 November opinion piece puts South Africa’s total private wealth at “about R10.6-trillion, excluding assets held offshore”. Although no source is provided, this value does correspond to the South African Reserve Bank’s 2018 estimate for household net wealth. The latest Reserve Bank Quarterly Bulletin (September) indicates that in 2019 this figure was R11.1 trillion (see the Table below). Based on this it is argued that a “once-off 25% tax on the richest 10%, with their 85% share of the wealth, would cover well over half the government debt”. As an alternative, it is stated that “a 25% wealth tax on only the richest 1% could net R1.45-trillion, reducing the government debt by more than a third”.

Unfortunately, at best this is an oversimplification of reality, hinging on the assumption that all wealth is stored in liquid (or easily accessed) assets. To determine the merit of the argument, it is important to analyse the balance sheet of households in more detail. The Reserve Bank’s 2019 data indicates that non-financial assets (notably residential property) make up roughly a third (34.6%) of household assets. (This is a contentious issue with large disparity in estimates in the available literature).  

Among financial assets, households’ interest in pension funds and long-term insurers makes up another third (34.3%). This already indicates how the bulk of household wealth is stored in diversified and “illiquid” assets, thus blunting the argument for a (“quick and easy”) wealth tax. Imagine the financial catastrophe that will follow should people be forced to sell their houses or cash in their pension savings to cover a wealth tax imposed on them.

What a wealth tax of this magnitude will probably accomplish is the exact opposite of what the author of the opinion piece envisaged. We would probably see massive resignations for members to access pension assets and a flight of capital to offshore tax havens. Keep in mind that South Africa’s progressive personal income tax structure and top tax rates (even when compared internationally), already place a significant financial burden on wealthier individuals, seen by some as an existing quasi-wealth tax. Some 600 00 individual personal income tax payers already contribute more than 50% of personal income tax, which is more than 20% of annual government tax revenue.

The reality is that with South Africa’s gross loan debt fast approaching R4-trillion (R3.9-trillion for the 2020-2021 fiscal year, according to the 2020 medium-term budget policy statement), the country needs a collective effort and long-term prudent management of fiscal affairs to first stabilise its growth and then start reducing the actual debt level. In the meantime, servicing this debt is going to cost South Africa R233-billion (2020-2021), which is expected to rise to R353-billion (2023-2024). In short, the government built a governance structure that taxpayers can no longer afford.

Loosening monetary policy

The second suggestion put forward in the 10 November opinion piece is to have a “high inflation rate” of 25%. The suggestion is that “with inflation the loan (or debt) becomes smaller in relation to gross domestic product” owing to real value being eroded by inflation. It is also argued that “inflation does not hurt our buying power as long as our incomes increase with it”. This statement is untrue: not all incomes (and particularly not the incomes of pensioners) increase with inflation.

This statement is also unsound from a policy perspective, because it rests on the assumption that “inflation is a policy instrument” that can be set at any given level for any given period of time. Inflation is not a policy instrument, it is the result of a price spiral, often exacerbated by the application of wrong policies.

To guard against inflation, central bank independence is treated as sacrosanct (and even enshrined in constitutions in certain instances) in most modern economies. For example, in South Africa we have an inflation target mandate for the Reserve Bank. Although it is given to the central bank by the government, the Reserve Bank has independence in the way it achieves this goal (operational independence). Any attempts to drastically loosen monetary policy will be in direct conflict with this mandate. Although we have seen some additional open market operations by the Reserve Bank during the Covid crisis, these actions were limited, clearly communicated and aimed at stimulating the larger economy, rather than dealing with government debt levels.

If ever there was a recipe for one of the fastest ways to ruin an economy, it will be to undermine the independence of the central bank, or in simple terms to “fire up the money printing presses”. Various examples exist of the long-term crippling effect of runaway inflation. Ironically, one of the countries mentioned by the author — Germany — experienced some of the worst hyperinflation in history.  

In addition, South African is a small, open economy that relies heavily on imports to sustain domestic demand and capital inflows to sustain the government’s borrowing requirement and domestic investment. The rand is one of the most highly traded emerging market currencies, making it extremely vulnerable to change in global sentiment or perceptions towards South Africa. Market rumours about tinkering with monetary policy (or questions over central bank independence) will send the rand into a tailspin. A scenario where the currency depreciates significantly while domestic inflation runs at 25% (that is, prices double roughly every three years) will have devastating effects on consumers, no more so the poorest of the poor.

The further notion that this will “reduce our high inequality” is factually wrong. The people most vulnerable to high inflation are the poor, while high income individuals are better positioned and advised on how to protect their wealth against the effects of inflation, for example by investing in a diversified portfolio of assets, domestically and offshore.

What is evident is that South Africa’s debt problem has been steadily building over a relatively long period, in this case roughly a decade. One should therefore be cautious to look for quick fixes in this regard, because the unintended consequences of these can often have significantly negative effects on the economy. The period in the mid-2000’s provides a practical example of the “correct” way to sustainably get debt back under control — to reignite economic growth, which will support revenue recovery, while managing expenditures in a prudent manner, in other words to try to at least balance the budget. Until then please do not chase away what is probably one of South Africa’s last saving graces — hard working taxpayers whose knowledge, capital, entrepreneurship and efforts will be crucial to make any form of recovery a reality.